- The first pillar defines capital requirements. It quantifies the minimum capital requirement (MCR) and the solvency capital requirement (SCR).
- The second pillar provides qualitative requirements in terms of supervision and review. Indeed, the European Commission wants to emphasize the need for insurance companies to implement efficient risk management systems.
- The third pillar introduces the market discipline concept. Insurance companies have to promote transparency and support risk-based supervision through market mechanisms.
Last week, the Hartford (USA) announced that it was refocusing its business strategy. The immediate impact of this change was to place its annuity business into runoff, and to initiate a search for a buyer (or strategic alternative if a buyer cannot be found) of its Individual Life, Woodbury Financial Services and Retirement Plans. In addition to this news from the Hartford, earlier this month we also saw the Prudential (USA) announce that it was going to discontinue the sale of individual long term care products.
In mature markets around the world, there appears to be a growing demand to either find new homes or alternative strategies for long-term business that no longer fits with the business strategy of insurers. In Europe, for example, Solvency II and local market reforms (such as the Retail Distribution Review in the UK) are acting as a catalyst for insurers to re-evaluate the economic viability of running these blocks as they reduce in size with age, and also with a view towards releasing capital.
So, if you’re an insurer with large block of non-strategic long-term business, what are your options?
The most obvious option, and preferred by many, is to find a buyer for the block. Although strategically, this can be the cleanest option for the insurer, it comes with two big risks. The first risk is brand reputation. Even though the products within the block may be viewed as non-strategic by the insurer, it is unlikely that the customers holding those products see them that way. Ultimately, these same customers may also be good prospects for other financial products and services. The second risk relates to transition. Ideally, the buyer of the closed block needs to be able to absorb the business into its existing operation without a drop in service quality or benefits to the customer. Typically, this will involve some level of convergence on processes and platforms with other similar blocks – not an easy task, and it is likely that the biggest share of the reputational risk associated with any failure still lies with the insurer who sold the block!
Other options range from financial restructuring through to outsourcing through to internal transformation. No option is straight forward, all involve some level of balancing the cost to serve with the reducing size of book, and all attract risk. Arguably, at the heart of any good strategy for closed blocks, should be an understanding of the value of the end customer holding the product, and how further value can be extracted from the relationship to the benefit of both parties (regardless of who manages / owns the block now).
At Celent, we are researching the options open to insurers for managing closed blocks and also strategies for maximising the value of the customers held within them. If you have an opinion on what the best strategy is for managing these old discontinued blocks of business, then we’d be keen to hear from you.
Getting back to December 2008, I wrote a blog post mentioning that Solvency II was under threat and that we could expect some more delays of its effective implementation. Last week the FSA in the UK announced that it is likely that the effective date of the new regulation implementation will have to be delayed by a year and enter into force certainly in January 2014. Actually this decision comes following the request from The Lloyd’s of London insurance market and the Association of British Insurers to obtain more clarity around the Solvency II implementation by FSA.
This is certainly good news for insurance companies as it gives them more time to prepare and take advantage of the Solvency II implementation not only to comply with the new regulation but also to understand the opportunities for risk management process and resources improvements and consequently make the right decision to mitigate their risks. With the change of the Solvency II roadmap I also expect from insurance companies to spend more money on preparation and change programs in order to promote a smooth transition. This delay will also allow insurers to dedicate more time to navigate the Solvency II IT vendor landscape. According to me, the Solvency II application landscape can be difficult to navigate for insurers even though some vendors have managed to bind strategic partnerships recently (acquisition of Algorithmics by IBM for instance). For more information about this market I encourage you to read the following report Celent has published last year: Solvency II IT Vendor Spectrum.
The big question mark going forward is whether the economic situation for the next two to three years will allow the regulator and insurance companies to work in a more stable environment to operate this transition.
Yesterday’s announcement by IBM, to acquire Algorithmics demonstrates the trend towards more concentration on the risk management vendor market. Algorithmics has been a successful IT vendor for many years taking advantage of new regulations such as Basel II and Solvency II to gain traction within the financial industry and IBM remains an IT infrastructure and core system development player benefiting from a strong reputation.
Following the mergers of Towers Perrin and Watson Wyatt to form Towers Watson and then the acquisition by the company of EMB, we think that the risk management vendor landscape is reproducing what is currently happening in the insurance policy administration system vendor market and we expect more concentration going forward.
For insurers working on Solvency II preparation programmes the merger of IBM and Algorithmics could be a great opportunity to consider a strong offering not only on the software side but also on the delivery aspects.
- Distribution: French CIOs understand that the distribution landscape is changing fast. They have all listed distribution as one of their priorities for 2010 and most of them intend to launch IT initiatives to take advantage of the growing importance of online insurance notably.
- Regulation: the Solvency II regulation framework affects directly insurers IT investment priorities. As the results of the quantitative impact study 4 launched by the CEIOPS in 2008 tend to demonstrate, there is a growing interest by French insurers in understanding what are the impacts of the new set of prudential regulation not only on their solvency ratios but also on their ability to comply with the other elements of the regulation. Some insurers have already invested in new IT systems for instance capital modeling tools but some others still need to understand what they have to start with and what they need to focus on to be ready in 2012.
- Improvement of core processes and cost reduction. Even though most of the CIOs interviewed so far clearly mentioned they had not really implemented drastic measures (layoff program, IT investments cancellation, etc.) following the financial crisis and the economic downturn, improvement of core processes leading to cost reduction via a smarter use of IT resources represents a priority for 2010.
In April 2008, Celent published a report about the new regulatory approach for insurers and reinsurers operating in the European Union called Solvency II.
Surprisingly or not, the draft text submitted to and approved in the beginning of December by the European Council of Economic and Finance Ministers (ECOFIN) does not contain the group supervision provision any longer. With Solvency II, capital requirement is based on a risk-based system as risk is measured on consistent principles. Knowing that, the removal of the group supervision requirement is an important change to the overall Solvency II regulation. Indeed, the idea behind Solvency II is to encourage large and diversified groups because they can pool their capital resources which should in turn benefits to policyholders. This approach is directly derived from the Basel II regulation implemented for the bank industry.
In other words, it seems that some factors have played an important role during the last six-month period and led the policy makers to reconsider the pros and cons of the group supervision provision. First of all, a few internationally diversified banks have nearly collapsed in the recent past demonstrating that the Basel II regulation could not prevent even well-diversified institutions from experiencing solvency problems. In the insurance sector, the American International Group (AIG) has been seriously hit due to its vast financial exposures that were written at the group level. In addition, after the massive interventions of governments to save some of the biggest European financial institutions, political pressures have emerged. France, for instance, seems to be in favor of the deletion of the group support element of the directive. This decision is also due to the fact that mutuals – which are preponderant in France – tend to have lower solvency ratios and capital requirements. Smaller countries in Eastern Europe are also concerned since they fear losing control over some of the entities. According to a report published by FSA in April 2008 (Enhancing group supervision under Solvency II), foreign insurance subsidiaries own 98.6% of market share in the Slovakian life sector and 100% in the non-life. These figures help us better understand the small Eastern European countries concern.
Overall, the immediate consequence of the ECOFIN decision could trigger new rounds of political discussions and delay the effective implementation of the Solvency II directive. In this context, Celent thinks that 2012 might be a too optimistic objective. However, we still encourage insurers to prepare for the Solvency II implementation because the new set of capital requirement regulation means changes and will trigger new investments anyway.